A V Rajwade: The Budget - A few question marks

Are monetary and exchange rate policies adding to the NPA burden? Is inefficiency of governance causing time and cost overruns for stalled projects, thus piling up NPAs?

As expected, the Finance Bill has a clause to amend the Reserve Bank of India (RBI) Act to formalise Consumer Price Index-based inflation targeting, and the constitution of a Monetary Policy Committee of six members (half from the RBI), with a casting vote for the RBI governor. One wonders if this does not vest too much macroeconomic policy power in the hands of one individual, particularly when fiscal austerity has become sacrosanct. Can it bias him towards high interest rates and an overvalued exchange rate? The latter may mean that increased domestic demand, on which the finance minister is banking for growth, may lead only to higher imports. The minister also referred to his success in maintaining the quality of the fiscal deficit even while reducing it. Will he also pay some attention to the quality of our record reserves of foreign exchange, which he took pride in? Equally important: Are the monetary and exchange rate policies contributing to the problem of banks' bad debts?

NPAs of public sector banks
The level of non-performing and stressed assets of public sector banks, which comprise 70 per cent of the industry, has risen sharply in Q3 results - at a time when gross domestic product growth has been strong, in fact, the highest among the world's major economies. Apart from the alleged corruption and incompetence of public sector bankers, are there other reasons for the phenomenon?

To my mind, if the RBI and the finance ministry have pushed the banks to follow more stringent asset quality norms, the other side is whether the price of money and the inefficient governance have not contributed to the deterioration in quality of the assets. The Wholesale Price Index, more relevant to businesses, has been negative for quite some time now and most borrowers are paying "real", that is, inflation-adjusted interest rates in double digits. No wonder the percentage of companies with an interest coverage ratio of less than one has practically doubled in Q3 of the current fiscal year from around 17 per cent in Q1 of fiscal 2012-13, according to data compiled by Credit Suisse (Mint, February 22). Few businesses earn a return on capital to afford real rates in double digits.

The central bank's argument is that it has done its job by reducing the short-term rate but that the banking system's transmission is very poor. But is the liquidity in the system adequate to bring the rates down? One indication: The 10-year benchmark yield has hardly changed over the last year during which the repo rate dropped by one per cent. Globally, central banks' lower interest rate policies have generally been accompanied by pumping liquidity into the market. This does not seem to have happened.

A contributory factor is the exchange rate, which is significantly overvalued and hurts the tradables sector. Given that the domestic prices of most commodities are governed by global prices and the exchange rate, it is no wonder that commodity manufacturers in India (steel, copper, aluminium etc) are finding it difficult to compete with imports and are incurring losses.

A third factor over which neither banks nor borrowers have much control is inefficiency of governance. When the present government came to power, the prime minister had promised less government, more governance. But the number of projects stalled during implementation due to land acquisition hurdles and delays in umpteen other approvals remains high. Time and cost overruns can cripple projects under implementation, thus adding to non-performing assets. E Sreedharan, praised for the way he implemented the Delhi Metro, recently cautioned the authorities about the proposed Nagpur-Mumbai bullet train, saying that each day's delay will increase the project cost by ~50 lakh.

Project finance has always been a riskier business than working capital finance. The history of Indian banking over the last 50 or 60 years shows that specialised project finance institutions like the Industrial Finance Corporation of India and the IDBI Bank incurred huge losses; the ICICI Bank converted itself into a commercial bank; and the IDFC Bank is following suit. Is the share of public sector banks in project/infrastructure finance disproportionately large? One wonders whether an unintended consequence of the recent criticism of public sector banks would be their unwillingness to lend. Surely, this is not going to be helpful to continued growth. As Deepak Parekh said in a speech in Mumbai last month, "Yes, we need transparency in accounting for NPAs, but surely the objective of the clean-up is to fix the financial rot, not incapacitate banks."

The author is chairman, A V Rajwade & Co Pvt Ltd; avrajwadegmail.com